Fairfax 2023

[MMM20]

Q for @Viking @Parsad and any others with a large % of their portfolios in FFH… if anything kept you up at night about holding FFH for the next 5-10+ years, what would it be? Is there some blowup risk I’m missing?
 

I have a really hard time seeing how more float is a bad thing. In all time worst catastrophe scenarios, well, they have a massive cash+fixed income portfolio to draw on to fund losses, survive, and enter the next hard market. Meanwhile, they have clearly structurally improved the insurance side and underwriting profitably - a massive asset, not a drawback - especially with borrowing costs otherwise off the zero bound. I get that it is more leverage, but seems to me it is basically the best kind of leverage - probably 0 or negative borrowing costs and not adding incremental blowup risk. 
What am i missing?

 

Edited March 1, 2023 by MMM20

[Parsad]

4 minutes ago, MMM20 said:

Question for @Viking @Parsad and any others with a large % of their portfolios in FFH… if anything kept you up at night about holding FFH for the next 5-10+ years, what would it be?
 

I have a really hard time seeing how more float is a bad thing. in all time worst catastrophe scenarios, well, they have a massive cash+fixed income portfolio to draw on to fund losses, survive, and enter the next hard market. meanwhile, they have clearly structurally improved the insurance side and underwriting profitably - a massive asset, not a drawback - especially with borrowing costs otherwise off the zero bound. I get that it is more leverage, but seems to me it is basically the best kind of leverage and not adding blowup risk.
What am i missing?

 

The leverage and lack of a strong third leg on the stool (wholly-owned, cash flowing businesses).  

 

I have a lot of FFH...probably a much larger sizing than most...other than Prem!    I've always bought it cheap when it was around 0.6-0.7 times book, so that's the margin that let's me sleep at night. 

 

What really lets me sleep at night...Prem and the team.  As Munger says, you shouldn't plan on getting rich twice.  That sentiment probably keeps FFH management from doing things where the leverage might put them in that position.  No one wants to ever be broke again!

 

As I got older, in non-taxable accounts, I've always reweighted it to a smaller, more reasonable position balanced by other stocks and plenty of cash when I can't find anything.  But in my personal holding company, I just let the unrealized capital gains ride and it makes up 40% of it.  But I do that with all my stocks in the holding company.  I don't want to pay taxes on any of those gains for a long, long time.  Again, I let the cash build in the holding company too, when I can't find something to buy. 

 

For the holding company, I'm looking at investments that I don't want to turnover...so it's a bit more selective.  You want compounding machines.  For the non-taxable accounts, I can put things like cigar butts in, because I don't care if I sell after it hits intrinsic value, since I don't pay any tax on the gains.  

 

So that's how I manage any risk from FFH and how I sleep at night.  I buy cheap and lots of it, and then sell in non-taxable accounts to reasonable levels.  Cheers!

[Viking]

4 hours ago, MMM20 said:

Q for @Viking @Parsad and any others with a large % of their portfolios in FFH… if anything kept you up at night about holding FFH for the next 5-10+ years, what would it be? Is there some blowup risk I’m missing?
 

I have a really hard time seeing how more float is a bad thing. In all time worst catastrophe scenarios, well, they have a massive cash+fixed income portfolio to draw on to fund losses, survive, and enter the next hard market. Meanwhile, they have clearly structurally improved the insurance side and underwriting profitably - a massive asset, not a drawback - especially with borrowing costs otherwise off the zero bound. I get that it is more leverage, but seems to me it is basically the best kind of leverage - probably 0 or negative borrowing costs and not adding incremental blowup risk. 
What am i missing?

@MMM20 i am likely in a unique situation. Most of my investments are in tax free accounts (RRSP, LIRA, TFSA, RESP). As a result, i can flex position sizes (both up and down) and not worry about taxes. in other words, holding because of a tax benefit does not exist for most of my investment portfolio. This greatly simplifies things for me.
 

I also do not think in terms of 5 year holding periods (let alone 10). That’s not to say i won’t hold a position for 5 years. When i buy a stock i usually have a holding period of 18-24 months in mind. I have a pretty good confidence level in my analysis over that period of time (3 years or more into the future… things get pretty murky).

 

I mostly only buy stuff that is cheap. And i only concentrate if it is very cheap (so risk/reward is highly skewed in good way). 
 

It should be noted, all companies can blow up. Including Berkshire Hathaway. Especially when Buffett/Munger/Jain are no longer around. All companies die. Eventually. There is no buy and hold forever (in a practical sense) - of course, i am exaggerating… a little. 
 

What could cause Fairfax to blow up?

1.) record catastrophe(s). It will happen. We just don’t know when. I.E. 1906 type earthquake on West Coast.
- cybersecurity is an interesting caveat.
- geopolitical tensions are escalating. What happens if large parts of US power grid get taken out? And life ceases to exist as we know it? (I.E. cell phones, computers, credit cards don’t work for a couple of weeks).

2.) company specific losses

- do i really understand Allied World’s business model? No. Odyssey’s? No. Ki’s? No. Could something happen at an insurance sub that might cause big problems at Fairfax? I’m sure its possible. Is it likely? No, I don’t think so.

3.) loss of key personnel. This would’t necessarily cause Fairfax to blow up. But losing ‘glue’ type people like Brian Bradstreet, Andy Barnard etc would be a big concern. If i got the feeling Fairfax was losing key people and the new guys were sub par, i would not want to hold the stock for +10 years. Quality of management is key.

4.) big bet risk. Do we get another ‘equity hedge’ type bet at some point in the future? Didn’t blow the company up but it did cause it to stagnate for 7 years.

5.) there are other smaller watch-outs for me:

- Atlas: i don’t understand this business very well. This is my problem. Not Atlas’s. Just lots going on right now. Significant new builds getting completed. Cost of debt is spiking (in general… not sure of exact impact on Atlas). China is quickly becoming a pariah. Global supply chains are shifting. What does it all mean for the container shipping market? No idea.

- Eurobank: What if pro-business government in Greece is defeated in next election and is replaced by hard left government. What if yields on Greek sovereign debt spike? Will total debt levels in Greece become a problem again? Bigger picture, what if Euro (currency) blows up? Not likely. But possible.

- India: what if Modi loses next election and new PM shifts country economically hard left? 
 

There are more (i am sure). Every company has risks. Fortunately, the really bad ones are very low probability so will likely never happen. 

 

 

Edited March 1, 2023 by Viking

[nwoodman]

Governance, leverage, opaque structure, availability of cash and hubris are the big one’s for me. When things go well they go very well but the leverage cuts both ways.  In general the structure is a short sellers wet dream as we have seen in the past.  Having said that, this “potential disaster”is now my largest holding (just) in my primary account and second largest in my retirement. Agree with the more prolific posters here that there have been improvements on all fronts and the current valuation still has an acceptable margin of safety

[Charlie]

I´m afraid of leverage, low quality businesses in low quality countries and management with a track record of leaving their circle of competence. So I never invested in them.

On the other hand they are very good value investors and good Buffett imitators. 

[Thrifty3000]

10 hours ago, MMM20 said:

Q for @Viking @Parsad and any others with a large % of their portfolios in FFH… if anything kept you up at night about holding FFH for the next 5-10+ years, what would it be? Is there some blowup risk I’m missing?
 

I have a really hard time seeing how more float is a bad thing. In all time worst catastrophe scenarios, well, they have a massive cash+fixed income portfolio to draw on to fund losses, survive, and enter the next hard market. Meanwhile, they have clearly structurally improved the insurance side and underwriting profitably - a massive asset, not a drawback - especially with borrowing costs otherwise off the zero bound. I get that it is more leverage, but seems to me it is basically the best kind of leverage - probably 0 or negative borrowing costs and not adding incremental blowup risk. 
What am i missing?

 

I’m in my early 40s and my family of 5 lives off our investment portfolio. FFH now makes up roughly a third of the portfolio at an average cost of ~$400 per share.

 

I think about my portfolio differently than most. I buy solid and growing look through earnings. Full stop.
 

I want my portfolio’s look through earnings to exceed my family’s annual expenditures by a WIDE margin (several times over).

 

I try to buy look through earnings for the lowest cost possible.

 

Even at the current stock price Fairfax produces the highest look through earnings for the price of any investment in my portfolio or watchlist. So it would make me sad to sell those earnings - equivalent to a pay cut.

 

Focusing on look through earnings helps me not obsess over the share price short term. 
 

It does make me obsess over the quality and sustainability of those earnings in relationship to my family’s expenditures.

 

In short, FFH is still my favorite.

[Luca]

Does anybody have a good overview of whats in their 15b equity portfolio outside of 13Fs, i have been trying to find some more information on it

[giulio]

Fairfax have been around since 1985. It survived bubbles, short sellers attack, hurricanes, earthquake and most importantly the GFC and Covid.

 

When natural calamities or pandemics have been in short supply they provided their own by shorting and hedging their portfolio during the longest bull market in history.

 

They have avoided lots of blow-up risk so far and seem in good shape to me.

 

To echo @Parsad comments, Mr. Watsa said various time that he would not do anything where he is "betting the company". His ego (in a positive sense) and his family's ownership stake are the most effective checks in place.

I also believe that Mr. Watsa deeply cares about Fairfax stakeholders and employees. He's proud of Fairfax's  compensation system and of the many employees who are now millionaires thanks to share appreciation.

 

That said, catastrophes will happen and there will be (big) losses but that's the nature of (re)insurance.

Mistakes will be made on the investment side as well, I hope the flowers will massively outweigh the weeds.

 

G

 

[Xerxes]

I can understand fascination toward Fairfax Financial, which is managed by an actual value investor [Watsa] who breathes value day in day out, but I don't understand this fascination with Markel.

 

How much of that fascination toward Markel comes from the "value investor" community for no other reasons that the company advertises itself as mini-Berkshire, and tailor its communication to that community.

 

Why there is no thread covering the Canadian insurance company called Intact [Ticker IFC.TO], which beat Markel over the past 10 years, but just doesn't do any folky talk and/or charm offensive. What is so special about Markel ? 

 

 

[Parsad]

6 hours ago, Xerxes said:

I can understand fascination toward Fairfax Financial, which is managed by an actual value investor [Watsa] who breathes value day in day out, but I don't understand this fascination with Markel.

 

How much of that fascination toward Markel comes from the "value investor" community for no other reasons that the company advertises itself as mini-Berkshire, and tailor its communication to that community.

 

Why there is no thread covering the Canadian insurance company called Intact [Ticker IFC.TO], which beat Markel over the past 10 years, but just doesn't do any folky talk and/or charm offensive. What is so special about Markel ? 

 

 

 

Intact is more of a general insurer...not a big reinsurance business.  Also it is more of a pure insurance company with no non-insurance businesses...it would be the Canadian version of Allstate.  It's business is also not particularly diverse on a global basis.  Great insurer and business...but again, a different animal than MKL, BRK or FFH. 

 

The fascination around BRK, MKL and FFH is because they do something quite different than most insurers when it comes to managing float.  Most insurers put float and premiums into fixed income securities to match their future insurance losses.  BRK, MKL and FFH not only buy equity securities with a significant amount of their float/premium portfolio but wholly-owned non-insurance businesses.  That creates more stability in income and tempers years of severe cat losses.  When done well, it also provides an outsized return compared to general insurance companies.

 

Cheers!

[SafetyinNumbers]

4 hours ago, Parsad said:

 

Intact is more of a general insurer...not a big reinsurance business.  Also it is more of a pure insurance company with no non-insurance businesses...it would be the Canadian version of Allstate.  It's business is also not particularly diverse on a global basis.  Great insurer and business...but again, a different animal than MKL, BRK or FFH. 

 

The fascination around BRK, MKL and FFH is because they do something quite different than most insurers when it comes to managing float.  Most insurers put float and premiums into fixed income securities to match their future insurance losses.  BRK, MKL and FFH not only buy equity securities with a significant amount of their float/premium portfolio but wholly-owned non-insurance businesses.  That creates more stability in income and tempers years of severe cat losses.  When done well, it also provides an outsized return compared to general insurance companies.

 

Cheers!

 

Parsad, would you lump WRB in with MKL, FFH and BRK? Are there any other insurers that you consider comps?

[mranski]

Allstate is not really comparable to Intact, as Allstate has their own retail branches. Also Intact has global operations now in Europe and US. A Canadian comparable to Allstate would be a for profit version of Cooperators Insurance. Also Intact writes some direct auto like a Geico. 

[MMM20]

Circling back on the normalized u/w profit discussion after reading Chris Bloomstran's latest letter.

 

I get to ~$5-10B for the capitalized value of FFH's own normalized u/w profit using more conservative assumptions than his on BRK. That's ~$200-400 IV per share for FFH from underwriting alone. 

 

FFH IV/share is ~$2,000+ using essentially the same methodology as Chris's BRK valuation. With more conservative inputs for the investment portfolio returns and multiples on economic profits... appropriately.

 

We are almost getting FFH's entire $40B cash/fixed income portfolio for free.

 

Or we are getting FFH's entire private+public equity portfolio for free twice or three times over. So no more whining about Blackberry, please

 

FFH is not BRK… IV will prob grow at a similar clip from here, but with wider dispersion in the range of outcomes for a host of reasons… but, FWIW, FFH (~$700 vs ~$2,000) is prob ~2x cheaper to IV than BRK (~$300 vs ~$400). And FFH is not exactly looking like a value trap either as they’ve seemingly flipped to highly cash generative and buying back stock in big chunks.

 

Someone check my math, I often need it...

 

 

 

 

 

 

 

 

Edited March 3, 2023 by MMM20

[racemize]

The problem with these very high IV calculations is that it really kills growth generally.  I.e., you had more growth when using BV/share because you were getting the leverage from the investments/share.  If you calculate IV at investments/share, then you have lost leverage, and it grows more slowly.  I've found that the added IV but lower growth pretty much offsets.  Happy to be wrong here though.

[Parsad]

18 hours ago, SafetyinNumbers said:

 

Parsad, would you lump WRB in with MKL, FFH and BRK? Are there any other insurers that you consider comps?

 

No.  WRB is missing that third leg of the stool...wholly-owned, non-insurance subsidiaries/businesses.  But it is a great insurer and they do manage their portfolio well. 

 

WTM sort of fits in the same category...they have held outside businesses and investments...back in the day, Leucadia would have fit...Loews Corporation definitely fits with CNA and their non-insurance businesses.  Wintaai/Stonetrust will fit that model...Francis Chou's vehicle.  Biglari Holdings fits the model.

 

Cheers!

[netcash1]

what is the stock symbol for the Francis Chou's vehicle?

 

[cwericb]

3 hours ago, netcash1 said:

what is the stock symbol for the Francis Chou's vehicle?

 

 

http://choufunds.com/

[newtovalue]

Anyone know when Prem's letter comes out?

[Viking]

6 hours ago, newtovalue said:

Anyone know when Prem's letter comes out?

i think it is Friday, March 10. To others: please correct me if i am wrong.

[giulio]

Yes, March 10th is what they said on the last cc

[newtovalue]

cool thx! hoping it was this weekend. have to be patient for one more week i guess

[Viking]

Despite what we have been hearing lately from politicians, share buybacks can be beneficial for shareholders if done in a responsible manner (purchased at attractive prices) and sustained over many years. Here is an update to a post I made recently.

 

Fairfax’s effective shares outstanding peaked in 2017 at 27.75 million shares. Fairfax issued a total of 7.2 million shares over 2015-2017 to help fund its international insurance expansion (Brit, Eurolife and mostly Allied). The average price of the newly issued shares was US$462/share.

 

At December 31 2022, the share count at Fairfax has fallen to 23.3 million shares. Over the last 5 years, Fairfax has reduced its share count by approximately 4.4 million shares or 15.9% = 3.2% per year (see table at the bottom of this post for details). The average cost paid by Fairfax over the past 5 years was US$464/share.

 

Fairfax book value is US$658/share. Shares are trading today at US$686/share. So Fairfax has been able to buy back shares in volume over the past 5 years at an average price well below both current book value and current market price. The average price of the shares repurchased over the past 5 years is about the same price at which they were issued +5 years ago. Interesting.

 

The big share repurchase came in December 2021, when Fairfax executed a substantial issuer bid and purchased 2 million shares at US$500/share for a total cost of $1 billion. To fund the purchase, Fairfax sold 10% of Odyssey for US$900 million. With Fairfax shares trading at US$686 today, this repurchase is looking like a great decision for shareholders.

 

Summary: Fairfax has been doing a solid job on the buyback front the past 5 years: share count has come down nicely and shares have been repurchased at attractive prices. I think we can safely conclude that Fairfax's share buybacks have been very beneficial for shareholders. 

 

What could we see in 2023? The good news is Fairfax’s free cash flow should be very high in 2023, driven by record underwriting income, record interest and dividend income and solid realized investment gains. The bad news is Fairfax’s share price is trading today at new all time highs (US$686) so Fairfax will have to ‘pay up’ a little.

 

My base case is Fairfax will repurchase about 2% of effective shares outstanding = 466,000 shares. The cost would be @$320 million (at $686/share). A much larger repurchase is also very possible.

 

Fairfax has lots of good options of what to do with their growing free cash flow:

1.) pay down debt: total debt actually increased in 2022 ($750 million at Fairfax and $100 million at Recipe)

2.) support growth of insurance business at subs: we are still in a hard market (especially property cat reinsurance)

3.) buy out minority partners: $733 million was spend in 2022 to increase ownership in Allied from 70.9 to 82.9

- while not technically a buyback, taking out minority shareholders does increase the amount of earnings that flows to Fairfax shareholders. Some on this board have likened this activity to a stock buyback.

4.) increase ownership in current equity positions: in 2022 Fairfax increased its ownership in:

- take private: Recipe and Grivalia Hospitality

- bought more shares: Fairfax India, Mytilineos, Micron

- exercised warrants: Atlas, Altius, Foran

- converted debs: Ensign

- converted preferred shares: Thomas Cook India

- issued preferred equity: Kennedy Wilson

- issued convertible debentures: John Keells

5.) invest in financial markets (lots of companies are cheap): new positions established in 2022:

- Bank of America, Occidental, Chevron, BABA

- JAB - JCP V investment fund

6.) buy back stock: bought back 2.3% of effective shares outstanding in 2022.

 

Based on what we saw in 2022, my guess is we see Fairfax continue to do a mix of all of the above. Perhaps the big move in 2023 will be to buy back another chunk of Allied (funded this time with free cash flow and not debt).

—————

Here is Prem’s quote from the 2018AR that suggests Fairfax will continue to be aggressive with share buybacks in the coming years: “I mentioned to you last year that we are focused on buying back our shares over the next ten years as and when we get the opportunity to do so at attractive prices. Henry Singleton from Teledyne was our hero as he reduced shares outstanding from approximately 88 million to 12 million over about 15 years. We began that process by buying back 1.1 million shares since we began in the fourth quarter of 2017 up until early 2019 – about half for cancellation and half for various long term incentive plans we have across our company. This was after we increased our ownership of Brit to 89% from 73% while having the funds ready to increase our ownership of Eurolife from 50% to 80% in August 2019.”

—————

Fairfax’s total return swaps on 1.96 million Fairfax shares: some on this board consider this investment to represent a buyback of sorts. Here is an update on this holding. It is turning into one of Fairfax’s best investments ever.

- Cost at Inception =        $733 million ($372.96) - initiated late ‘20 & early ‘21

- Value Dec 31, 2022 =     $1.167 billion ($594.12 share price)

- Value March 3, 2023 =  $1.345 billion ($686.25 share price)

 

Increase in value of position from inception = $612 million = + 83% over 28 month holding period (not including any costs  to maintain TRS position).

—————

Edited March 5, 2023 by Viking

[Xerxes]

In hindsight, Allied World was bought by issuing shares being issued at or above book value while the bulk of the share issued were bought back over the next 5+ years by repurchasing those below book value. Some substantially below book value.

 

Don't know the exact numbers, but that is a job well done. Even if it was not planned that way.

[SafetyinNumbers]

33 minutes ago, Xerxes said:

In hindsight, Allied World was bought by issuing shares being issued at or above book value while the bulk of the share issued were bought back over the next 5+ years by repurchasing those below book value. Some substantially below book value.

 

Don't know the exact numbers, but that is a job well done. Even if it was not planned that way.

 

I think the issuance of the shares was definitely planned that way. Before Henry Singleton bought stock back at low valuations he issued a lot of stock to grow at high valuations. That's exactly what Prem did because when shareholders were big fans of what ended up being bad trades, the stock had positive Social Value i.e. it traded above Intrinsic Value. He used that paper to make what have ended up being incredibly accretive acquisitions. I chuckle when people tell me they don't like the stock because they don't think Prem is a great capital allocator. They are only looking at the non-insurance side and quite frankly they are wrong about that too as we are all about to be reminded once again.

[glider3834]

Something I just picked up from Markel's Q4 results

'While these measures, considered independently of other factors, fall below our internal targets, we remain confident in the strong operating performance of our businesses. In addition, we give consideration to the following information in assessing our compound annual growth in book value per common share:

• Amortization expense - As we grow through acquisitions, our intangible assets grow. GAAP requires that we amortize a portion of these acquired intangible assets, which is a non-cash charge to net income. Amortization of acquired intangible assets for the five-year period ended December 31, 2022 totaled $763.2 million.'

In 2021, Fairfax recorded an approx $97M non-cash amortization expense for customer & broker relationships. It has averaged around $100M for FFH over the last 4 years. This expense is largely included in corporate overhead & other and related to acquisitions of Allied World & Crum & Forster

'Conversely, the concept of recording charges against other intangibles, such as customer relationships, arises from purchase-accounting rules and clearly does not reflect economic reality.' ( Buffett)

 

Given the significant growth in their insurance/reinsurance subs since acquisition, I think there is a strong case to argue this expense doesn't reflect economic reality or true 'owner earnings'.

 

If we add back this expense for last 6 years (2016-21) , FFH's book value would increase by around US$500M and pre-tax earnings by around US$100M per year.

 

Since 2009 to 2021, the total accumulated non-cash amortization expense for customer & broker relationships is US$577M.

 

Cheers

 

 

 

 

 

Edited March 6, 2023 by glider3834